After completing the last article on the introduction of REITs, I started wondering at the flexibility of Islamic finance, which is able to fulfill all needs of a modern-day Islamic investor so that he or she does not have any feelings of the Islamic financing principles curtailing his or her urge to benefit from the new investment channels.
Not only that, the Islamic financing and investment parameters protect the investor from harm as I had described with real life examples while explaining the nitty-gritty of an Islamic fund.
Taking the example of REITs: the fractionalization of property ownership was the phenomenon observed for an inherited property if the deceased leaves behind parents, wives, several sons and many daughters. As per the inheritance law described in Sura Nisa (Chapter 4) of the Holy Quran, verses No 11–14, they all own the share in the property jointly based on the ratio specifically mentioned for each type of inheritor.
A scholar had once quipped that the inheritance is so clearly defined in the Quran that you do not need an accountant for the allocation of the ownership of the inherited wealth and that any person can easily find out the share he or she has inherited.
The ratios not only apply on the immovable properties inherited by the heirs but also on the other kinds of wealth such as cash, gold and silver. Add to that the current perspective that they also do apply on bank accounts, shares and bonds (or Sukuk), cars, businesses and any other form of wealth.
As such, when the first REIT was introduced in Islamic finance with the concept of pro-rata ownership by scores of investors, the concept was not alien to the Shariah scholars who willingly approved it, albeit with the customary caution that the assets must not be used for any Shariah-repugnant purposes.
So, therefore, the flexibility of the Islamic financing principles was successfully tested when the REITs started entering the Islamic finance arena and were warmly greeted by the Islamic institutional and individual investors.
It is important that I set the record straight before moving on that a conventional REIT where the assets are not being used for any non-compliant activity cannot still be classified as an Islamic REIT and declared open for Islamic investors. This argument has emanated from a Southeast Asian country that such REITs should be considered as permissible for Islamic investors.
The reason why I am not in agreement with such a proposition is that for a REIT to be approved for Islamic investors, it is mandatory that its documentation are drawn on Shariah lines, and reviewed and approved by the REIT’s Shariah board through a formal Fatwa. Moreover, the Shariah board will carry out periodical Shariah audits on all REIT matters and transactions and discard any tainted income found in the profit and loss account (tainted income includes interest income and any other impermissible earnings), and finally allocates Zakat from the net income, prior to the distribution of dividends to shareholders. All of this is absent in a conventional REIT even if its assets are not breaching any Shariah boundaries.
When I worked on providing advisory for the first Islamic REIT launched in the UAE, a situation arose when an ultra-large international conventional financial institution desired to acquire on a long-term basis the full floors of a high-rise building recently included by the REIT in its ownership portfolio.
Most certainly, it was a very lucrative proposition for the REIT operator not only from a financial perspective but also with regards to prestige. Nonetheless, much to the disappointment of the REIT’s operator, the Shariah board stood its ground and did not allow the property to be leased to a conventional financial institution. In their decision, the Shariah scholars mentioned that the REIT operator may lease the floors to the conventional financial institution for the sake of prestige (which may help to attract other tenants), provided it is prepared to donate the entire rental income to charity. Need I say that the operator never went back to the Shariah board for any unreasonable demands thereafter.
Although I expect my readers to know by now as to which assets may not qualify for an Islamic REIT, at the cost of repetition, I provide below a short checklist comprising the no-go areas. These are conventional resorts and hotels, shopping centers where Shariah-repugnant activities are carried out (save as these can be carved out), buildings with branches of conventional banks, insurance companies and any other conventional financial institutions if housed in the building (save as these can be carved out while purchasing the asset).
A narrow window does exist where the Shariah board may allow the REIT to proceed for the acquisition of assets with repugnant tenancy income, provided it is below a certain threshold (say 5% of the total REIT income) and that such an amount is donated by the REIT operator to charity as part of purification before distribution to shareholders.
The purpose of this educative series and the article is not to hurt any religious or commercial sentiments either consciously or even unwittingly.
Sohail Zubairi is an Islamic finance specialist and AAOIFI-certified Shariah advisor and auditor. He can be contacted at sazubairi1979@gmail.com.
Next Week: Discussion of Islamic REITs to continue.
